BRUSSELS, Jan 10 (Reuters) - The euro zone must use itsrescue fund to inject money into banks with past debts, thepresident of the Eurogroup said on Thursday, warning anythingless would undermine the bloc's crisis response.

In a major step last June, EU leaders agreed to allow theEuropean Stability Mechanism (ESM) to directly recapitalisebanks and reduce the burden on countries such as Spain andIreland, whose governments are carrying large amounts of debtafter propping up banks when real estate bubbles burst.

But Germany, the Netherlands and Finland have since saidthere was never any question of past bad banking debts beingshifted off the states' books and onto the ESM.

Resolving the issue is one of the biggest challenges facingEU finance ministers this year to cement a series of steps takenin 2012 that prevented the break-up of the euro zone.

"There is a major question over the legacy issue and whetherwe should limit the intervention of the ESM to new problems,"Jean-Claude Juncker, who chairs monthly meetings of euro zonefinance ministers, told the European Parliament.

Juncker, Luxembourg's prime minister who leaves theEurogroup post later this month after almost a decade in thejob, said he hoped it would be solved before the end of March.

"I think there must be some degree of retroactivity in themechanism, otherwise it will lose most of its sense," Junckertold members of the Parliament's influential Economic andMonetary Affairs Committee.

Direct recapitalisation by the ESM would break the linkbetween indebted banks and euro zone countries, marking asignificant step in resolving the bloc's debt crisis thatstarted out with banking problems five years ago.

Berlin, The Hague and Helsinki are worried about the ESM, towhich Germany is the biggest donor, taking stakes in banks inexchange for the recapitalisation funds. The maximum lendingcapacity of the ESM is 500 billion euros ($652 billion).

Juncker urged solidarity, particularly as EU financeministers in December agreed to set up a single supervisor foreuro zone banks - a precondition set by leaders for allowingdirect ESM recapitalisation.

"Countries of the north are not more virtuous than countriesof the south. They should take a look at their own books," hesaid to applause from some MEPs in the packed chamber.

Ireland is burdened with debt that is greater than itsannual economic output, representing a big risk for investors inits sovereign debt. But it is close to returning to financialmarkets and exiting its sovereign bailout, and retroactive helpfrom the ESM could help Dublin on its way back to normality.

Spain could also be saved from any kind of full sovereignbailout if the 40 billion euros in euro zone bankrecapitalisation money it has received is not permanentlyaccrued to central government balance sheets.

FRENCH BANK POLICEWOMAN?

Juncker also effectively confirmed expectations that hissuccessor as Eurogroup president will be Dutch Finance MinisterJeroen Dijsselbloem, although he declined to give details.

"I will speak to my successor in a Benelux language,"Juncker told MEPs, referring to the region of Belgium, theNetherlands and Luxembourg.

Dijsselbloem's French counterpart, Pierre Moscovici, hasbeen talked about as another possible candidate to lead theEurogroup. But the Dutchman, who met with Moscovici on Thursday,appears to strike the right balance as a centre-left politicianfrom a fiscally disciplined northern European nation.

Dijsselbloem is expected to be named on Jan. 21 at the nexteuro zone finance ministers meeting in Brussels.

While France may have missed out on the Eurogroup job,Juncker said that a Frenchwoman would head the board of theECB's new banking supervision authority that was agreed lastyear and which is due to be in place in early 2014.

Although Juncker offered no names, the secretary general ofFrance's ACP financial sector regulator, Daniele Nouy, has beenregularly cited as well placed to chair the board.

The French finance ministry and the Bank of France, whichhouses the ACP, declined to comment on the matter.